It is late 1999 and you are a successful oil executive currently working in Alaska for a major oil company. Tomorrow morning you will have the opportunity to negotiate with your employer to receive some amount of deferred salary in 5 years in exchange for $75,000 of your year 2000 compensation. If this compensation is not deferred, it will be paid to you on December 31, 1999, as a year-end bonus. Both you and your employer can earn a before-tax rate of return of 12%. Your employer's combined federal and state income tax rate is 40% and is expected to remain constant throughout the 5-year period.
Because Alaska does not have an individual income tax, you will pay only a federal tax of 39.9% on income earned in 1999. However, you are being transferred to New York at the beginning of next year, where you will be groomed for a top-level position in the firm. You expect your combined federal, state, and city income tax rate to be 50% in the year 2000 and to remain at this level throughout the 5-yer period.
a. What is the highest deferred-compensation payment your employer would be willing to pay?
b. What is the lowest deferred-compensation payment you would settle for?
c. Can you and your employer get together and write a mutually beneficial deferred compensation contract?
a. Yes, by accepting the employer%u2019s offer because it is higher than your minimum required amount.
b. Yes, by considering the effective compensation from increased tax brackets incurred from you minimum.
c. No, the maximum the employer is willing to pay is not high enough to meet minimum you are willing to settle for